ffirs.indd vi 6/24/10 7:44:21 AM Praise for History of Greed “David Sarna has written an important, readable, erudite, and compelling book that delves into all of the dark corners of the fi nancial markets in a way that only one who is a knowledgeable intellectual like David and who has seen, as David has, the inner workings of the markets can do.” —Andrew Malick Chairman, Needham & Co. “David Sarna has provided a close-up, insider’s view of some of the shenanigans going on in and around the fi nancial capitals of the world. It is very readable, entertaining, and almost funny until you realize all the lives that have been hurt by the combination of at best amoral and more correctly criminal acts aimed at investors of all stripes who foolishly expected and chased outsized returns. Sarna describes all this against a backdrop of regulatory complacency, along with overgenerous bonuses and salaries for the titans of fi nance and industry who added little if anything to the quality of life for those who did not ride the gravy train with them.” —Jonathan Harris, CPA Retired Senior Partner, Big Four accounting fi rm “David Sarna is a visionary technologist. He is also a sophisticated investor and fi nancier. He has written a readable, comprehensive, fasci- nating, and well-researched book that explores troublesome aspects of the fi nancial system in a way only an experienced insider could.” —Jay N. Goldberg Senior Managing Director, Hudson Ventures “A comprehensive review of what has happened to us in our fi nancial markets over and over and over and over again. It’s an important history, written with wit and delivered with wisdom. Undoubtedly, History of Greed will become required reading by anyone serious about under- standing the capital markets.” —Frederick L. Gorsetman Founder and Managing Member, Oxbridge Financial Group LLC ffirs.indd i 6/24/10 7:44:19 AM “Fascinating! I did not think the trading of securities and reading about it could be that absorbing.” — Carl Nisser Counsel, McGuire Woods Former Judge at Svea Court of Appeal, Stockholm “History of Greed is right on the money and quite timely. I found a lot of information and much I did not know, and I have been around the industry for a while. It made me feel like a dunce once I saw how the manipulative trading on the over-the-counter (OTC) stock market really works.” —Philip Fox Insurance Executive and Former Broker ffirs.indd ii 6/24/10 7:44:20 AM History of Greed F inancial F raud from T ulip Mania to Bernie Madoff David E. Y. Sarna John Wiley & Sons, Inc. ffirs.indd iii 6/24/10 7:44:20 AM Copyright © 2010 by David E. Y. Sarna. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifi cally disclaim any implied warranties of merchantability or fi tness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profi t or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Sarna, David E. Y. History of greed : fi nancial fraud from tulip mania to Bernie Madoff / David E. Y. Sarna ; [foreword by] Andrew Malik. p. cm. Includes bibliographical references and index. ISBN 978-0-470-60180-8 (hardback); ISBN 978-0-470-87769-2 (ebk); ISBN 978-0-470-87742-5 (ebk); ISBN 978-0-470-87770-8 (ebk) 1. Fraud— Case studies. 2. Commercial crimes— Case studies. 3. Avarice— Case studies. I. Title. HV6691.S27 2010 364.16'3 —dc22 2010010929 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 ffirs.indd iv 6/24/10 7:44:20 AM For my family, with all my love ffirs.indd v 6/24/10 7:44:21 AM ffirs.indd vi 6/24/10 7:44:21 AM Contents Foreword xi Acknowledgments xiii Introduction xv Chapter 1 Selling Air 1 Why Now? Chapter 2 Crash Postmortem 7 How Greed, Hubris, and Lack of Supervision Did Investors In Chapter 3 Why We Do It 14 Bubbles and Fraud Chapter 4 Securities Fraud 20 Its Long and Storied Past Chapter 5 The Perils of Greed 31 It’s All for the Easy Money Chapter 6 The Elements of Financial Fraud 36 A Case Study with “Crazy Eddie” Antar Chapter 7 “Other People’s Money” 43 The O.P.M. Leasing Fraud Chapter 8 Smaller-Company Fraud 48 The “ISC” Story Chapter 9 Selling Long and Short 58 But Mostly Short vii ftoc.indd vii 6/24/10 7:44:59 AM viii contents Chapter 10 Market Manipulation 63 Improper Short Selling and Other Abuses Chapter 11 PIPEs 73 Investing Unfairly Chapter 12 Promotion Fraud 91 Pump and Dump Chapter 13 Leaks, Front-Running, and Insider Trading 100 Test Yourself Chapter 14 Fictitious Volume 108 A Pump-and-Dump Scam with Intrigue Chapter 15 Parachute into Prison 116 U.S. v. Schrenker Chapter 16 Affi nity Group Fraud 121 Scamming Your Own Community Chapter 17 Twentieth-Century Ponzi Schemes 127 Larger and Longer-Lasting Scams Chapter 18 Hit Charade 132 Lou Pearlman Chapter 19 Hedge Fund Ponzi Fraud 137 Hedge Funds Are for Big Boys Chapter 20 Madoff and the World’s Largest Ponzi Scheme 146 The Mother of All Ponzi Schemes Chapter 21 How Madoff Got Away with It 161 Who Helped Plot in the Mother of All Ponzi Schemes; Who Can Be Made to Pay? Chapter 22 Madoff Plea and Its Aftermath 186 Governments Go after Merkin, Kohn, and Maybe Others in the Mother of All Ponzi Schemes Chapter 23 Mopping up after Madoff 204 Lawyers Feast on Madoff Feeders in the Mother of All Ponzi Schemes Chapter 24 Other Recent Ponzi Schemes 225 Madoff was a Crook but He Had No Monopoly on Recent Ponzi Schemes Chapter 25 Stanford Group 244 Massive $7 Billion, Multinational Fraud Comes to Light ftoc.indd viii 6/24/10 7:45:00 AM Contents ix Chapter 26 Ultimate Chutzpah 259 The Strange Tale of Marc Dreier, Esq. Chapter 27 Detecting Fraudulent Financial Schemes 266 How Much to Regulate? How Much to Verify? Chapter 28 Fraudulent Offerings 285 A Short Look Chapter 29 Auction-Rate Securities 287 A $330 Billion Fraud? Chapter 30 $132 Million Tax-Free Exchange Fraud 301 Section 1031 Chapter 31 Not Smart 306 The Smart Online Trading Scam Chapter 32 Boiler Rooms 314 Where the Heat Rises Chapter 33 Accounting Frauds 319 With Examples Chapter 34 Stock Option Frauds 325 Alchemy That Benefi ts Insiders Chapter 35 Odd and Unusual Financial Frauds 329 Not Your Everyday Fraud Afterword What Does the Future Hold? 333 Notes 338 About the Author 382 Further Reading 384 Index 387 ftoc.indd ix 6/24/10 7:45:00 AM ftoc.indd x 6/24/10 7:45:00 AM Foreword n my more than 40 years on Wall Street, I ’ ve had the opportunity to participate in more than 1,000 transactions, but I have written I very few Forewords to books. However, when David asked me to write the Foreword to History of Greed , I couldn ’ t say no. David Sarna has written an important, readable, erudite, and compelling book that delves into all of the dark corners of the fi nancial markets in a way that only one who is a knowledgeable intellectual like David, and who has seen, as David has, the inner workings of the markets, can do. Ever since the Dutch invented shares and limited liability com- panies as we know them around the year 1602, capital markets have fueled the growth of countless companies, created millions and millions of jobs, and produced great wealth for nations, entrepreneurs, and investors. I ’ ve had the good fortune to be associated with some of the most successful capital raises of all time, through initial public offerings of such technology companies as Intel, Cray Computing, Tandem, Lotus Development, and Qualcomm.